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Dear Sir,
I have a problem with this question and could not find answer anywer.
Luke Co has 8% convertible loan notes which are redeemable in 5year’s time at par. Alternatively, each loan note could be converted after 5years into 70equity shares with a nominal value of $1.The equity shares of Luke Co are currently trading at $1.25 each, and this price is expected to grow by 4% per year.The before-tax cost of debt of Luke is 10%, after-tax cost of debt is 7%. Required: What is the Current Market Value of each loan Note?The answer is following:
Using a conversion value after 5 years of 106.40(1.25*1.045*70)and before tax cost of debt of 10%, we have (8*3.791)+(106.40*0.621)=96.40.
I could not understand why the Interest amount did not include the tax,should not we deduct tax from interest, and why we are given 2 costs of debts-before and after tax? which should be chosen?
Many thanks and grateful in advance. Regards. LilitIt is investors who determine the market value, and investors receive the full interest – tax is not relevant at all.
Tax is only relevant when calculating the cost of debt to the company because the company gets tax relief on the interest.
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